What kind of rate of return can an average, equities-focused algorithmic trading firm expect to achieve today?

I come from a background of control and optimization, working in the industry in China, but I also work with a team to do investments and trading on the side.

In our market, which has a very different set of rules, it seems that the most profitable investment strategies are medium-term in time horizon. The yearly rate of return, for skillful private investors with several million USD, can be about 50% or so, but this number does, of course, vary from year to year.

Recently a trader working at an investment bank, with a mixed background working with investment funds and as a quant developing high-frequency trading models, tried to persuade us to try algorithmic trading in the western markets.

He claims that with several million USD's investment he can achieve a yearly return rate of 100% in the US stock market with the strategies he developed recently.

I just want to know if this is possible? I know his algorithm is quite different than those that can be found in the published journal papers on finance.

Although this seems to be OK (I doubt any good strategies will ever be published and we sure won't publish ours), but he failed to explain his strategies in much detail. From his point of view this is understandable, but it has certainly created a lot of doubt on our part.

One detail I learned from talking with him is that his method involves event-driven trades and requires a lot of text-mining.

$\begingroup$Welcome to Quant.SE, thanks for posing your question. We're trying to grow the community so please keep coming back and participating.$\endgroup$
– Louis MarascioNov 18 '12 at 14:41

$\begingroup$I think that he's probably decided that mining twitter for events and information on company popularity is a good idea. It's a reasonably interesting concept, but certainly can't be relied on for generating income on its own. Even if you collated your twitter data with data from other similar social sources.$\endgroup$
– cal97gFeb 14 '14 at 23:56

2 Answers
2

Whether its possible? Absolutely. However, you should probably keep in mind a couple points:

* Many people claim a lot while proving very little to none. This is fine if the issue is a small-talk conversation. Believe it or not, no harm done. However, this is about money, and from my experience I cannot stress enough how important it is to do a very intensive due diligence on your part. Ask him to prove that he is worthy of your investments. Ask him for audited broker statements which detail his past trades so that you can build a more credible risk/return profile and see whether the statistical results speak in favor of funding him. Ask him to somehow send you live execution notifications of his currently live running strategies. Its very simple to code up a small application, especially for people active in algorithmic trading. If he rejects to show any sort of proof or verification then I would be more than careful.

* Should you ever invest with him then I recommend you make sure your funds are segregated from any other of his funds. Its very simple in a professional "umbrella fund structure". You basically open an account in your own name while giving him trading authorization in your account. In that way he is unable to withdraw or transfer funds out of your account.

* Keep in mind China is still a very inexperienced wild-west market in terms of financial investments. I say this because I spent almost my entire career in East Asia, Tokyo, HK, Singapore, Shanghai, now Tokyo. Chinese investors are a very special kind of breed when it comes to investments. Most are still having completely irrational expectations. They want a guy to generate 50% return, if at year end he generates 45% then they kick him out, and move all their money overnight into real estate. Then when the real estate market cooled down they moved all their funds into commodities and gold, and such forth. There is no loyalty, no trust, no nothing in China when it comes to investments. Expectations of achievable returns are exaggerated and so are promised by those who manage funds. Thus, I would be very careful about claims of someone able to generate 100% returns. Its doable, sure, but the risk of blowup grows exponentially, and the draw downs in between may be a lot larger than you can stomach. Do you feel comfortable waking up one morning and reading in your email inbox that your investment overnight tanked by 15-20% just because your fund manager concentrated all in that "hot" stock that he got some secret tips about and invested in? Be my guest, but I would ask very hard and potentially challenging questions in terms of what his thoughts are on risk/reward. If I speak to someone managing money and he mentions "returns" earlier than "risk" then he is OUT, SIMPLY OUT. Believe me, someone who promises you something without first mentioning the risk behind it should be avoided int his particular industry. Why all those comments about China and Chinese investors? Because I get the sense that you also have slightly unrealistic expectations of achievable returns within the framework of sane and sound risk management. If you get all crazed up by someone promising 100% then something is wrong, or do most people get excited when they watch a telemarketer on TV promising that the USD 3.99 gem can really heal sicknesses? My advice to you: Be realistic what to expect. The US stock market is not the Chinese real estate market 10-15 years ago.

Take my advise or leave it, its your choice, but I would be very careful about someone who says he can generate 100% returns. It sounds extremely fishy and unprofessional.

Good luck!!! (i hope you dont need it)

P.S.: After I finished writing this and read your question again, I smirked, then shrugged, then felt pain. I actually recommend you to run, do not invest with such person, I am almost willing to bet (not the farm but a significant amount) that currently its close to impossible to generate 100% returns on a significant investment in US stocks on event based strategies. The probability of me being wrong is probably somewhere between 0.02%-0.5%. Just my 2 cents.

$\begingroup$I upvoted for the style, but investing in sophistication to trade at HF is not a bad idea. But I agree, that particular trader looks odd.$\endgroup$
– SRKX♦Nov 16 '12 at 0:50

$\begingroup$Good point, thanks, the guy himself has a good track record on trading(otherwise we may not even have such talks), but he left the US bank 5 years ago and return home, so I am not very sure he is still keep in touch with the market over there, althrough he claimed so. As for your other advices, very useful, our current investment style is not very agressive, and we only invest stocks, not derivatives/futures. as for the sharpe ratio, his claimed 100% rate of return is also largely stocks along, not some high risk products, thats why we were interested to hear more.$\endgroup$
– user1748356Nov 16 '12 at 2:38

2

$\begingroup$I have come across just so many people in this industry who are outright cheats, liars, and pretentious human beings. Whether someone worked at a tier 1 firm, hedge fund, says he has a good track record all means one thing: NOTHING!!! Trust is good, control/verification is better. About your last statement: I think you err a little in that regards. Generating 100% returns on US cash equity on the funding you mentioned is close to impossible. Its easy to achieve that on the fx side, or with other leveraged products. You may just blow up tomorrow. Hope this helps clarify.$\endgroup$
– MattNov 16 '12 at 4:56

$\begingroup$Agree with this answer but want to add a point about checking the scalability of his strategy too. Generally anytime you want to scale up a strategy to any kind of significant size, the returns do tend to suffer as market impact et al increase with your size while opportunity shall generally decrease with it. So you might want to verify what size he is talking about when he claims a 100% return as well.$\endgroup$
– HungryFoolishMar 27 '14 at 13:49

$\begingroup$I pointed out it is possible but unless you are one of the top high frequency houses (with Sharpe ratios north of 7-10, translating approximately into a single day of losses in like 5 years) achieving 100% returns off the back of alpha generated (and not pure luck) is nearly impossible, especially not on "millions of dollars".$\endgroup$
– MattMar 27 '14 at 13:58

You will struggle to put a number on the potential returns of high-frequency trading (HFT) and I think it wouldn't make any sense anyway if you don't take into consideration its risk and its leverage. Achieving 100% return with low volatility seems highly improbable; so ask the trader in question his Sharpe ratio to start with and compare it with yours.

From a more economical - or even philosophical - point of view, you can notice that, to trade at higher frequencies you need to invest more money in sophistication of your trading form. Moreover, I believe this cost will look more exponential than linear.

So the question might be is there a payoff in the markets for this kind of sophistication?

I think the answer to that is yes, because by getting to higher frequencies, your are able to trade different kind of strategies and different kinds of events. According to the efficient market hypothesis (EMH), inefficiencies should disappear instantly as market participants notice them. So, the fewer participants you have at a higher frequency, the better the chance you'll have to get a large piece of the cake.

Note: you can do algorithmic-trading at a lower frequency as well, but then my point above is not really valid anymore, although it is still about payoff for sophistication

$\begingroup$Many thanks for this fine input, very useful, in case if its possible, can you tell me is there anywhere I can get some informations about technique details/trends about the algrothims employed in HFT/AT in the west at the moment?$\endgroup$
– user1748356Nov 16 '12 at 2:46